Forecasting market tops and bottoms using judicious trend lines

By Glen Deen

If the Dow-Jones 30 Industrials Average continues its saw-tooth pattern that we have seen since August 8, 2011, one can profit from predicting its tops and bottoms. For example, after closing on Friday October 14, 2011, I predicted the most recent top of 11,647 occurred that day (the high), and the next bottom of 10,440 will occur on October 21, 2011 as the low for that day.

The trading range is bounded between two parallel and gently sloping resistance and support trend lines that are predicted by making them tangent to selected daily highs and lows. Selecting these tangent points is an art. These lines shift from time to time but may remain stable for several cycles of oscillations. These lines are presently sloping upward at the rate of +0.02462816% per day. The present trading-range resistance trend line is tangent to the daily highs of 11,530 on August 17 and 11,647 on October 14. The trading-range support trend line has the same slope and is tangent to the daily low of 10,404 on October 4.

The market swings in a saw-tooth pattern between those trading range support and resistance trend lines. The 47 trading days from the bottom of 10,604 on August 9 to the recent top on August 14 are divided into the following swing intervals in days: rise 6 + fall 2 + rise 9 + fall 6 + rise 6 + fall 2 + rise 3 + fall 5 + rise 8 = 47 days. These rising and falling swings are called channels, and they are bounded by parallel rising and falling support and resistance lines. These channel lines are chosen to be tangent to as many daily highs and lows as possible. The initial slope of a rising channel may be estimated to be the reverse of the previous falling channel slope. As the channel ages, its sloping limits can be revised as new daily highs and lows are experienced.

The following illustrative table of channel slopes is not exact because the slopes are calculated from market tops and bottoms and the intervals between them, not from tangent points to daily highs and lows. The “days” column is the number of trading (not calendar) days in the interval.

Date Datum Value Days to Date Datum Value Slope/day

08/09 bottom 10,604 6 08/17 top 11,530 +1.40513%

08/17 top 11,530 2 08/19 bottom 10,801 -3.21293%

08/19 bottom 10,801 9 09/01 top 11,717 +0.90857%

09/01 top 11,717 6 09/12 bottom 10,825 -1.31104%

09/12 bottom 10,825 6 09/20 top 11,550 +1.08631%

09/20 top 11,550 2 09/22 bottom 10,597 -4.21434%

09/22 bottom 10,597 3 09/27 top 11,369 +2.37167%

09/27 top 11,369 5 10/04 bottom 10,404 -1.75836%

10/04 bottom 10,404 8 10/14 top 11,647 +1.42073%

The daily slope formula is simple. Consider the first line of the table. Slope = (11,530/10,604)^(1/6) = 1.0140513. Subtract 1 and multiply by 100 to get +1.40513%.

This technique fails when the user fails to see that his trend lines have become obsolete and need to be redefined.

For example, we can see now in retrospect that the August 31 and September 1 daily highs were about 1.35% above what we now regard as being the trading range resistance trend line. However, at that time our resistance line would have had a slope of:

Slope = (10,801/10,604)^[1/(6+2)] = +0.23036%/day

We would have been looking for a high on 09/01 of

Expected High = 11,530*1.0023036^11 = 11,826.

But the actual high of 11,717 fell 0.923% short. Any undershoot or overshoot of more than 0.5% is a problem. Furthermore, that day and the next 2 days were down days. This would have told us that our trading range resistance slope was too steep. We would know for sure on 09/06 because the low for that day of 10,932 went 1.3% below our forecast low of 11,078. We might call this a downside breakout.

Forecast low for 09/06 = 10,801*1.0023036^11 = 11,078.

Our forecasting would have been unreliable until at the earliest 09/12, so we might be well advised to sell everything and stay in cash until we had enough data to give us reliable forecasts. That would occur with the top of 11,550 on 09/20. At that point, we could use that top and the 08/17 top of 11,530 as our new tangent points, and just ignore the daily highs of 08/31 and 09/01 in computing the slope of the trading range.

I make all these calculations for myself and for my Yahoo group (FreeStockMarketForecasts) subscribers. I am not a skilled day trader, but my performance over the 52 trading days from 07/29/11 to 10/12/11 was +19.4%. The general consensus (including me) is that this is just a lucky streak.

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